The 1929 stock market meltdown explained in simple terms.
The autumn of 1929 witnessed the biggest stock market crash in history with people losing billions and opening the path to the longest economic depression in the industrialized world. When it comes to duration and aftermath, it is even bigger than the 2008 financial crisis (I’ve written about it here: The 2008 global financial crisis explained in simple terms.).
The years after the first world war were characterized by wealth and a rise in industrial production and growth which were naturally accompanied by a rising stock market fuelled with speculation that didn’t truly justify the current fundamentals. A bubble is defined as an unjustified rise in market value. But before discussing the crash and the aftermath, we have to discuss the main causes that led to this crisis.
- Overheating economy.
Overheating, overconfidence, and overproduction were three words to describe most of what was happening. First of all, the unjustified rise in stock prices meant that the buying of the shares was purely for speculative reasons. The buyer didn’t really care about the prospects of the company in a few years, he was only looking to join the party with everyone else. Of course many industries beforehand showed increases in profits (namely, steel production and railway), but people went overboard with the buying activity. Second of all, overconfidence of market participants led to the fact that they didn’t have a plan B in case there was a crash, everyone was sure that markets will continue to go up forever. And third, industries were overproducing products which led to a glut. This means that the excess supply will force prices lower and thus companies suffered.
- Easy credit.
This is self-explanatory and everytime we see the word easy credit, we know that there is trouble ahead. During the years leading up to the crisis, there was a huge growth in bank credit and loans. Buying on margin also fuelled this bubble as it is the act of borrowing money from stockbrokers while providing very little collateral.
- Interest rates.
Weeks before the crash, the Federal Reserve raised interest rates from 5% to 6%. Rising rates means costlier borrowing costs for companies, thus, lowering profitability and economic growth. Jobs can also be lost due to the impacted earnings.
- A fuel from the London Stock Exchange.
Days before the the US stock market crash, a top British investor named Clarence Hatry and some of his associates were jailed for fraud, prompting the London Stock Exchange to crash and infecting its American peer with pessimism. By this time, it was very unstable and so any bad news could have a magnified negative effect.
As is the case in every crisis, panic amplifies the negative effects and worsens the impact. Amidst the panic and the crash, people started to withdraw their funds from banks (or tried to). This effect led banks to fail even quicker than one would expect
Needless to say, stocks started to gradually decline until October, 1929, where the fall grew more serious. During that time, panic started to further amplify the effects and even though big investment companies and banks tried to stabilize the market by buying shares, the market didn’t stop there and kept heading south.